A blog of the NYU Colloquium on Market Institutions and the Leipzig Colloquium on the Market Order

On confidence and/or trust

In English we often use the words “trust” and “confidence” interchangeably and it usually doesn’t matter. I can say either “I’m confident that this ladder won’t collapse” or more simply “I trust this ladder.” However, I think the second way of stating it, apart from being a little less specific than the first, is actually metaphorical. It treats the ladder as if it were a person whom we can trust or distrust.

Robert J. Shiller’s article in the Wall Street Journal of a couple of weeks ago, “Animal spirits depend on trust,” in addition to being highly problematic in other ways, offers good examples of this ambiguous usage, to wit:

A critical aspect of animal spirits is trust, an emotional state that dismisses doubts about others. In talking about animal spirits, Keynes sought to convey the message that swings in confidence are not always logical. (Emphasis added)

Of course it’s not the words but the concepts behind them that are important, and when we’re talking about a particular politico-economic system, such as the political capitalism of the United States, or a subset of that system, such as the financial sector, the distinction can matter, as I think it does now.

When a “system,” a set of ordered relations, is working it generates regular and predictable outcomes on which we can confidently rely. A ladder as a system is, of course, a set of inanimate relations, no part of which has “agency,” the capacity to make choices (e.g., a nail doesn’t decide whether or not to do its job). But when the critical elements of a system, such as the postal service, are actual persons it works to the degree that the unpredictability of those persons is kept to a minimum, when everyone conforms to her role.

It’s when a carrier, say, can choose willy-nilly whether or not to deliver our mail that the system qua system begins to break down and our confidence in it is shaken. At that point, our personal relationship with the carrier begins to play a more important role in that, given our realization that she may very well choose not to deliver our mail, we are now placed in a position of having to trust her (or not) to do her job. This capacity of persons to make choices and to be unpredictable is the sine qua non of trust, and what we place trust in is the agency of those on whom we rely not to act opportunistically.

I came across the distinction between “confidence in a system” versus “trust in persons,” which I know not everyone buys, in Adam Seligman’s The Problem of Trust. As I understand it, it can be traced in some form at least from Georg Simmel through Niklas Luhmann. Interestingly, Seligman argues that trust in this sense is something relatively new, “a solution to a particular type of risk is a decidedly modern phenomenon, linked to the division of labor in modern, market economies” (p. 8). It’s in the unpredictability and radical uncertainty entailed by agency, particularly in a commercial society under the division of labor, that both the opportunity and the necessity to trust arise.

So how might this relate to, and perhaps shed light on, present economic problems as well as on the proposed solutions?

I think Mario touched on it in an earlier post when in a different context he wrote,

One hears a lot about restoring confidence in the economy these days. What is that? The economy is a complex entity. In fact, Friedrich Hayek wanted to drop the use of the term and replace it with “catallaxy” that is, an abstract order of interpersonal exchanges. The word “economy” has its origins in the idea of household management and consequently of a household manager. It is remarkable how the etymology of the word is preserved in its current meaning (or, at least, connotation). Most macroeconomists seem to believe that the economy can be managed or steered out of its current difficulties.

The market or catallaxy, when it’s working well, enables agents operating in it to pursue their own choices and plans, but it does not itself plan and choose (again, except metaphorically). We therefore would say that we do or do not have confidence in the market – and here I’m thinking of the relatively unfettered market rather than political capitalism – but not that we “trust” the market.

Trust, however, is indispensible for a dynamic market process, especially where novel rather than routine situations and persons are regularly encountered. But this is trust largely at the individual, face-to-face level, not at the systemic level. Indeed, problems arise when we try to shift trust from the individual to the systemic level.

The catallaxy, qua complex social system, works precisely because it’s impersonal. In fact, we could argue that, up to a point, the market process works to the extent that we don’t have to trust others to “do their job.” Once again, it’s when the system breaks down that the personal dimension and trust looms very large, whether it’s the mail carrier or a new president.

So having relied confidently on the financial system for many years, and having recently experienced its sudden and largely unexpected collapse (the interventionist causes of which have been discussed on ThinkMarkets and elsewhere), the conventional wisdom is that the process of recovery requires that we first overcome the current crisis of confidence. True enough. But the bottom line here, however, is that restoring confidence entails reducing radical uncertainty and this means reducing, not increasing, agency – whether in the form of bail-outs or so-called stimulus – in the recovery process. Instead, however, we are being told that recovery (and perhaps beyond) will require trusting in the ideas, intelligence, and goodwill of our political leaders.

Anyway,the concept of trust, by itself, is rather ambiguous. One kind of trust is a function of how certain or how much you know about something or someone: Russel Hardin refers to this as “cognitive trust.”

The other kind of trust requires a “leap of faith” that overcomes the gap between what we currently know (or think we know) and how much we would need to know in order to go ahead and rely on the other person (and this doesn’t have to be certainty or perfect knowledge): Hardin calls this “behavioral trust” I think.

Economists in the post-war period have focused on rational behaviour because they lacked good theories of non-rationality. Financial market practitioners have not however had the luxury of tackling only problems suited to their theoretical toolkit. Is it possible that they might have found some preliminary answers to understanding animal spirits that draws upon the insights of older schools of economics?

John Mills (1867, not JSM)thought that the business cycle was a credit cycle driven by confidence, and observed that the bust only revealed the destruction that had already taken place during the bust – both insights that seem very compatible with a subjectivist, Austrian approach.

Keynes was only therefore echoing earlier observers such as Mills when he spoke of action as based on ‘spontaneous optimism’. That suggests a mood with a physiological correlate, that might have its own natural rhythm to it and be influenced by exogenous forces acting on the organism as well as responding to a rational assessment of business conditions.

Trust and confidence after all are emotional patterns produced by the interaction of the hypothalamus with the rest of the endocrine system. Why should such interactions conform to our rationality-based preconceptions?

Should this be true, one’s understanding of the business cycle might best be furthered by studying animal spirits on their own terms, rather than trying to reason about how they ought to behave.

Prechter’s development of the Elliott Wave Principle might be one such approach. It is surely to his credit that he got the mechanism of the unwind correct, even if his timing was a little bit off in some ways.

I would note also Garcia-Mata’s re-examination of the sunspot theories of Jevons Sr and Jr. Recent behavioral finance studies suggest that cloudy weather in New York and geomagnetic storms both influence returns in the very-efficient stock market. So the idea that there could be exogenous drivers of risk appetite might perhaps not be as outrageous as it might first sound.